U.S. Department of Housing and Urban Development …

U.S. Department of Housing and Urban Development

Office of Single Family Housing Washington, DC

Flood Insurance for FHA Loan Originations

Office of Audit, Region 7 Kansas City, KS

Audit Report Number: 2021-KC-0002 January 5, 2021

To:

From: Subject:

Joseph Gormley Deputy Assistant Secretary for Single Family Housing, HU

//signed// Ronald J. Hosking Regional Inspector General for Audit, 7AGA

FHA Insured $940 Million in Loans for Properties in Flood Zones Without the Required Flood Insurance

Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector General's (OIG) final results of our review of Federal Housing Administration (FHA)-insured loans to determine whether loans in special flood hazard areas met flood insurance requirements.

HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on recommended corrective actions. For each recommendation without a management decision, please respond and provide status reports in accordance with the HUD Handbook. Please furnish us copies of any correspondence or directives issued because of the audit.

The Inspector General Act, Title 5 United States Code, appendix 8M, requires that OIG post its reports on the OIG website. Accordingly, this report will be posted at .

If you have any questions or comments about this report, please do not hesitate to call me at 913-551-5870.

Office of Audit (Region 7) 400 State Avenue, Suite 501, Kansas City, KS 66101

Phone (913) 551-5870, Fax (913) 551-5877

Visit the Office of Inspector General website at .

Audit Report Number: 2021-KC-0002 Date: January 5, 2021

FHA Insured $940 Million in Loans for Properties in Flood Zones Without the Required Flood Insurance

Highlights

What We Audited and Why

We audited Federal Housing Administration (FHA)-insured loans originated in calendar year 2019. We compared location data from FHA-insured loans to National Flood Insurance Program (NFIP) data to identify a targeted universe of properties that we believed were at risk of not having the required flood insurance. We reviewed a statistical sample of these loans. We initiated this audit because a prior Office of Inspector General audit found that FHA did not always ensure that lenders complied with Federal requirements for properties located in special flood hazard areas (SFHA)1. Increased access to data created an opportunity to perform a more comprehensive review of compliance with FHA's flood insurance requirement. Our audit objective was to determine whether FHA insured loans that were not eligible for insurance because they did not have the required flood insurance coverage.

What We Found

FHA insured at least 3,870 loans that closed in 2019, totaling $940 million, which were not eligible for insurance because they were made for properties in SFHA flood zones without the required NFIP coverage. We found loans that had private flood insurance instead of the required NFIP coverage, NFIP coverage that did not meet the minimum required amount, or no NFIP coverage at the time the loan was closed and endorsed.

What We Recommend

We recommend that FHA require lenders to provide evidence of sufficient flood insurance or execute indemnification agreements for the 43 loans in our statistical sample that did not have sufficient flood insurance at the time of our audit. We also recommend that FHA add to HUD databases the information necessary to ensure that the required flood insurance is in place at loan origination, including flood zone, flood insurance type, flood insurance amount, and site value of the property, and include system checks that prevent endorsement of loans without the required flood insurance.

1 HUD Did Not Always Ensure That FHA Lenders Complied with Federal Requirements When Submitting Loans for New Construction Properties Located in FEMA's Designated Special Flood Hazard Areas, Audit Report Number: 2008-CH-0002, Issue Date: September 29, 2008.

Table of Contents

Background and Objective......................................................................................3 Results of Audit ........................................................................................................5

Finding: FHA Insured $940 Million in Loans for Properties in SFHA Flood Zones

Without the Required Flood Insurance .......................................................................... 5 Scope and Methodology...........................................................................................8 Internal Controls....................................................................................................10 Appendixes .............................................................................................................. 11

A. Schedule of Funds To Be Put to Better Use............................................................11 B. Auditee Comments....................................................................................................12 C. Criteria.......................................................................................................................13 D. Exception Summary..................................................................................................15 E. Sampling and Projections.........................................................................................17

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Background and Objective

The Federal Housing Administration (FHA) provides mortgage insurance on loans made by FHAapproved lenders throughout the United States and its territories. FHA mortgage insurance provides lenders with protection against losses as the result of homeowners defaulting on their mortgage loans. The lenders bear less risk because FHA will pay a claim to the lender in the event of a homeowner's default. Loans must meet certain requirements established by FHA to qualify for insurance.

The National Flood Insurance Act of 1968 (Public Law 90-448) established the National Flood Insurance Program (NFIP). The NFIP is a Federal program that enables property owners in participating communities to purchase flood insurance as protection against flood losses, while requiring State and local governments to enforce floodplain management ordinances that aim to reduce future flood damage. More than 22,100 communities in the United States participate in the NFIP, and more than 5.1 million NFIP policies are in force, providing $1.25 trillion in content and building coverage.

The NFIP is managed by the Federal Emergency Management Agency (FEMA). Policies can be obtained from NFIP direct flood insurance or through the NFIP Write Your Own Program. The Write Your Own Program allows participating property and casualty insurance companies to write and service NFIP flood insurance policies in their own names. The Federal Government retains responsibility for underwriting losses. FEMA maintains a database of policy data for NFIP direct policies and policies obtained through the NFIP Write Your Own Program.

The Flood Disaster Protection Act of 1973 (Public Law 93-234) made the purchase of flood insurance mandatory for federally insured loans in special flood hazard areas (SFHA). An SFHA is an area within a floodplain having a 1 percent or greater chance of flood occurrence in any given year. SFHAs are defined on maps issued by FEMA for individual communities. The National Flood Insurance Reform Act of 1994 directed regulated lending institutions not to make, increase, extend, or renew any loan secured by properties in SFHAs without meeting certain conditions. The Act also required development of a "Standard Flood Hazard Determination Form" that identified the type of flood-risk zone in which a property is located.

The Biggert-Waters Insurance Reform Act of 2012 (Public Law 112-141) further amended the Federal flood insurance statutes to encourage private-sector participation. It did not apply to FHAinsured loans but, instead, applied to other types of loans. The Act required that those lenders provide borrowers a notice encouraging them to consider and compare private market flood insurance policies with NFIP policies and to accept such private flood insurance policies as satisfaction of purchase and flood insurance coverage requirements. It additionally stated that acceptance of private flood insurance policies may require verification that insurers meet specific independent rating agency criteria relating to financial solvency, strength, or claims-paying ability, which indicate that the insurers can satisfy claims.

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FHA's current rules regarding the requirement to maintain flood insurance coverage on property located in an SFHA do not permit private flood insurance as an option to satisfy the purchase requirement. Regulations at 24 CFR (Code of Federal Regulations) part 203 contain the borrower and lender requirements for flood insurance coverage. To qualify for FHA insurance, properties in an SFHA must be covered by NFIP insurance in an amount equal to either the outstanding balance of the mortgage, less estimated land costs, or the maximum amount of NFIP insurance available, whichever is less. Our objective was to determine whether FHA insured loans that were not eligible for insurance because they did not have the required flood insurance coverage.

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Results of Audit

Finding: FHA Insured $940 Million in Loans for Properties in SFHA Flood Zones Without the Required Flood Insurance

FHA insured loans for properties in SFHA flood zones that did not have the required flood insurance. This condition occurred because FHA did not have adequate controls to detect loans that did not have the required flood insurance. As a result, the FHA insurance fund and borrowers were exposed to greater risk from at least $940 million in loans that did not obtain adequate NFIP coverage.

Loans for Properties Without the Required Flood Insurance FHA insured loans for properties in SFHA flood zones without the NFIP flood insurance required by Federal regulations.

Federal regulations require NFIP insurance for FHA loans for properties in flood zones known as SFHAs. FHA's Single Family Housing Policy Handbook 4000.1 states that lenders are prohibited from processing a loan for an FHA-insured mortgage for properties in an SFHA flood zone unless NFIP insurance is in place. The handbook also establishes minimum amounts of coverage. (See appendix C.)

FHA insured at least 3,870 loans that closed in 2019, which were not eligible for insurance because they were made for properties in SFHA flood zones without the required NFIP coverage. We compared location data from FHA-insured loans to FEMA flood zones. We identified 28,105 FHA-insured loans that closed in 2019, which appeared to be in areas that required flood insurance. We matched the properties to NFIP flood insurance policy records provided by FEMA to determine whether the required flood insurance appeared to be in place at closing. We identified 15,483 loans that either did not have the required flood policies or had policies that might not meet the minimum amount required by FHA guidance. We reviewed a statistical sample of 125 of these loans and determined that 43 loans in our sample were made for properties in SFHA flood zones that did not have sufficient flood insurance. These loans included 33 loans that had private flood insurance instead of the required NFIP coverage. Because FHA does not allow private flood insurance and has not issued any guidance for private policies, we did not have standards available to test these private policies for sufficiency of the provider, policy terms, or coverage amounts. Nine loans had an NFIP policy that did not meet the coverage minimum, including one loan that had a private policy in addition to the NFIP policy. Another loan did not have a flood insurance policy in place when the loan was closed or endorsed. (See appendix D.) We used these results to project the total number and value of ineligible loans insured by FHA. (See appendix E.)

Controls Lacking To Ensure Adequate Flood Insurance FHA did not have adequate controls to detect loans that did not have the required flood insurance.

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FHA did not require underwriters to enter information into HUD systems to show compliance with Federal flood insurance regulations. Underwriters did not enter information into FHA's system regarding whether an NFIP flood insurance policy was obtained or the coverage amount. They also did not enter the flood zone or the site value, both of which would be needed to determine whether insurance was required and if so, the minimum coverage amount. All of this information could be entered from documents within the case binder. The flood zone determination is on the Standard Flood Hazard Determination Form, the site value is on the appraisal, and the insurance type and coverage amount are on the insurance policy documents.

FHA also did not have a control to prevent endorsement of loans that did not comply with the flood insurance requirement. As discussed above, FHA did not have flood insurance information entered into its databases by underwriters. Additionally, FHA did not have an interface established with FEMA to verify whether NFIP policies existed for FHA-insured properties. Because flood insurance information was not in HUD databases, loan file review was required to detect loans with inadequate NFIP flood insurance. However, FHA's postendorsement underwriting reviews were unlikely to detect most flood insurance issues because only 3 to 4 percent of loans were selected for review, while less than 1 percent of the total loans closed in 2019 had flood insurance issues. If HUD had underwriters enter the necessary data into its system, edit checks would be the most practical way to address this issue.

Risk From Ineligible Loans The FHA insurance fund and borrowers were exposed to greater risk from at least $940 million in loans that did not have adequate NFIP coverage.

The FHA insurance fund was exposed to greater risk because loans worth $940 million, which were not eligible for insurance coverage, were included in the FHA portfolio. The inclusion of these loans in FHA's portfolio negatively impacted FHA's achievement of Office of Management and Budget policies for Federal credit programs. Each department has a responsibility to make every effort to effectively target Federal assistance and mitigate risk by ensuring that lenders and servicers participating in Federal credit programs meet all applicable financial and programmatic requirements.

Borrowers with private flood insurance might be exposed to additional risks. Private insurance might not include guaranteed renewal, rates might increase dramatically, and the policies might include coverage limitations. While private insurance can be tailored to meet or exceed the NFIP standards, that cannot be assumed for private policies acquired without FHA guidance and oversight.

Conclusion FHA improperly insured loans for properties in SFHA flood zones without the required NFIP insurance. This condition occurred because FHA did not have information in its system that would be needed to identify flood insurance issues, making it unable to prevent endorsement of ineligible loans. HUD would be able to detect and mitigate this issue during review of loan files, but because more than 96 percent of the loan files were not reviewed by HUD, the lack of the required flood insurance was often not detected. By implementing our recommendations, HUD will be able to identify the lack of flood insurance and avoid insuring at least $940 million in

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